Liam Dann: Baby milk hotter than heroin in Hong Kong

Margins are attractive for the sale of NZ infant formula in China and there is danger of a gold rush mentality.

China's growing middle classes are willing to pay high prices for products they see as crucial to their babies' wellbeing. Photo / Richard Robinson

When you're selling a product that's hotter than heroin, odds are there's going to be a few issues to deal with.

Last week Bloomberg News reported that arrests of infant formula smugglers had surpassed those for heroin and other drug runners at Hong Kong's border, after it introduced new laws restricting how much can be carried into mainland China.

As of last Tuesday, Hong Kong Customs had arrested 879 people carrying more than eight tonnes of baby formula - the new laws were only introduced onMarch 1.

Only 420 people were arrested last year for carrying restricted drugs, including heroin and cocaine.

Some of the formula arrests might be put down to ignorance of the new law, but Hong Kong Customs has uncovered an infant formula syndicate in possession of four tonnes of product, worth more than $166,000.

Either way, the sheer scale of arrests offers some insight into just how much infant formula is being imported into China directly by international travellers - and how hot demand is.

The one-child policy has seen China's growing middle classes ready to pay high prices for products they see as crucial to their babies' wellbeing.

Combined with consumer concern about the safety of some local food products (heightened by the dreadful Sanlu scandal which saw babies poisoned by doctored formula), this is driving demand for internationally produced formula to new heights.

New Zealand formula has one of the best reputations - some might say ironically, given Fonterra's involvement as a joint venture partner with Sanlu - and exporters here are benefiting from the soaring demand.

The value of New Zealand's baby formula exports grew from $63 million in 1999 to $753 million in 2009, according to the Food & Grocery Council. It is now likely to be pushing $1 billion.

The fledgling New Zealand Infant Formula Exporters Association, which represents 13 players - although not Fonterra, A2, Synlait or New Image - claims to be exporting $684 million worth a year.

The big players are just gearing up to meet the seemingly insatiable demand. NZX-listed A2 milk sent its first shipment up to China last week and Fonterra will launch its Anmum brand formula into China later this year.

The Chinese retail market for infant formula has been estimated to be worth US$6 billion ($7 billion) and this is tipped to double by 2016. At that rate we could expect to see New Zealand's infant formula market worth more than $2 billion within three years - perhaps more if Fonterra's clout sees us upping our share of the total market.

We're also seeing more Chinese investment in the industry here. This month China's Yashili received approval to build a $212 million milk-processing plant at Pokeno - the first standalone Chinese dairy investment in New Zealand.

South Canterbury producer Synlait - which will make the formula for A2 - is 51 per cent owned by Shanghai-based Bright Dairy & Food Co.

And China's biggest dairy company, Yili, will spend $214 million establishing an infant formula plant in South Canterbury as a result of its planned takeover of Oceania Dairy group.

Locally processed infant formula is the right kind of dairy for New Zealand to be exporting - even when the capital investment is coming from offshore.

Infant formula is, as we used to say last decade, an "added value" product. In other words it takes more capital and labour to produce but the profits on it are much higher than they are for raw milk powder - which New Zealand still exports more than one million tonnes of each year.

A quick calculation - based on Hong Kong Customs' estimate of infant formula value ($41,500 a tonne) and Fonterra's global dairy auction price for wholemilk powder ($6185 a tonne) - indicates a mark-up of almost 600 per cent. Processing in New Zealand means jobs. So the benefits of this boom within a boom are many.

But the high margins also bring serious risks. A can of infant formula which sells in a New Zealand supermarket for $20 is worth about $70 in China. That kind of price margin has forced New Zealand supermarkets to put limits of the sale of formula because people have been buying it up to export privately.

Margins for the sale of infant formula are so high everyone wants to get in on it, which is understandable.

But there is a risk of a 19th century gold rush mentality taking hold - unregulated, wild west stuff. It is a market in which New Zealand's reputation as a safe and healthy food producer is absolutely crucial.

Chinese media are extremely sensitive to any hint of a food scandal. The DCD fertiliser issue reported in February put an immediate dent in sales of small infant formula exporters, although this seems to have been short-lived.

Efforts by local exporters to form an industry association to keep control of the New Zealand brand are admirable but have not been fully inclusive and have caused conflict within the fast-growing sector.

It looks as though it might be time for the Government to take a serious look at how New Zealand's reputation is being managed.

Infant formula ticks all the right boxes as a smart, high-value export making the most of our excellent agricultural economic base. It doesn't need heavy-handed regulation to slow down its growth, but it looks like an industry in need of some outside assistance to set up a sensible marketing strategy and ensure long-term success for all.

Liam Dann is the Business editor of the New Zealand Herald, overseeing all our business content in print and online. He has been a journalist for 20 years, covering business for the last 14 of them. He has also worked in the banking sector in London and travelled extensively. His passion is for Markets and Economics, because they are the engine of the New Zealand economy.